This above quote about the ‘ideal investment’ is regularly attributed to Warren Buffet.
Whether the reference is apocryphal or genuine, it is a definition that Lazard Asset Management’s Global Listed Infrastructure team has great empathy with and one that drives our thinking in identifying an attractive universe of assets.
This concept — an investment combining lower risk of capital loss with robust inflation protection and real growth — arguably captures what investors are looking for in real assets.
But does such an investment exist in the real world?
The Lazard Global Listed Infrastructure team believes that a select pool of real assets does in fact possess many of these characteristics.
They are what the team calls ‘preferred infrastructure’.
These assets can provide a contractual inflation link in cash flows, stable returns through economic cycles, a lower risk of capital loss, “rising coupons” through real earnings growth and, finally, diversification benefits with low correlations to other asset classes.
Passing the test
To qualify as ‘preferred infrastructure’, companies must have:
- monopoly or monopoly-like characteristics;
- a low elasticity of demand, typically because they provide essential services such as gas, water, electricity, or transportation;
- either an implicit or explicit link to inflation in their contractual or regulatory arrangements;
- be located in stable political and regulatory environments with a track record of consistency and respect for investor rights; and
- sustainable levels of financial leverage.
Infrastructure companies that have significant exposure to competition, commodity price volatility, excessive financial leverage, exposure to risky political environments, or inadequate asset lives will not possess the unique characteristics that ‘preferred infrastructure’ companies can provide to investors.
The listed infrastructure universe is vast relative to other methods for investing in these assets, such as private equity.
By some estimates, the opportunity set is composed of approximately 400 companies and US$5 trillion in market capitalisation as at 30 June 2014.
Our universe of ‘preferred infrastructure’ represents approximately 100 companies.
In this regard, we are continually assessing opportunities and projects around the globe, including railways in the US, toll roads in Italy and Australia, and airports in Germany.
Unique characteristics of 'preferred infrastructure'
The concept of increasing prices with the rate of inflation is not unique to real assets or infrastructure. In theory, any business can increase prices to pass inflation on to the consumer, but few can do so without a negative effect on demand.
This does not apply to ‘preferred infrastructure’ assets.
‘Preferred infrastructure’ companies are regulated monopolies that provide essential services, therefore when they implement price increases, consumers typically do not have an alternative.
Hence, demand is far less affected than it would be in a competitive market.
The nature of ‘preferred infrastructure’ companies gives them an enviable ‘moat’, even in times of economic uncertainty.
Regardless of the economic environment, people need to travel and commute to work (using toll roads, rail lines, and airports), turn on the water (using water utilities), and power their homes and businesses (using power transmission and distribution grids) – yet they may delay purchasing new cars, shoes, and computers.
For example, Consolidated Edison, the monopoly provider of electricity to New York City and Westchester County, NY, for more than 120 years, has grown volumes by 4.2 per cent over the five year period through 2012, which included the 2008–2009 recession, despite increasing average electricity tariffs by 14.4 per cent over the same time period.
Often the inflation pass-through for ‘preferred infrastructure’ is timelier than that of other real assets because it is usually reflected in revenues with a short time lag.
For example, Hills Motorway, a toll road in Sydney, can raise tariffs each calendar quarter at the greater of the consumer price index (CPI) or one per cent per quarter for the life of its concession (until 2048).
Lazard’s approach
We believe that the case for ‘preferred infrastructure’ within a broad based allocation of real assets and in an overall portfolio context is compelling.
However, historically, investors have had difficulties in accessing ‘preferred infrastructure’ assets due to a limited universe of publicly-traded companies and lack of available investment strategies from global investment managers.
To overcome these hurdles Lazard’s Global Listed Infrastructure team has built a proprietary universe of approximately 100 companies with a combined market capitalisation of more than US$1 trillion.
In our view, a disciplined stock-selection approach relying on fundamental analysis is optimal for accessing these investments.
The expertise and nuances for ‘preferred infrastructure’ valuation we believe requires a well-considered technique that differs from traditional methodologies for general equities.
In addition, we believe it is not optimal to attempt to access infrastructure investments through index investments and expect to receive favourable risk-adjusted returns.
We believe that navigating the infrastructure asset class, especially the subset of ‘preferred infrastructure’, requires skilled and careful management not provided by passive solutions.
Warryn Robertson is the portfolio manager of Lazard Asset Management's global listed infrastructure division.
